Cash extraction strategy

Given the current market situation, some of you may be looking to continue to grow their share portfolio but are hesitant to invest further funds and/or are opposed to selling down a portion of their existing share portfolio, as this will trigger a Capital Gains Tax (CGT) event. This will also reduce the potential income stream (via dividends and franking credits) and result in them forgoing any further upside in the stock.

An alternative method is to convert existing share holdings for instalments, which can diversify an investment portfolio in the sharemarket. The strategy is known as -Cash Extraction' or a -Shareholder Application'. It is ideal for those who do not have or wish to invest further funds into the market, or for those who have experienced significant capital growth in their existing share holdings and do not wish to trigger a CGT event. It also you the ability to spread risk and build a wider asset base.

Implementing the strategy

'Cash extraction' or a shareholder application involves lodging shares you already hold with the issuer (through the instalment's PDS), and in return receiving an equivalent number of instalments plus a cash payment. The cash payment represents a loan by the issuer to you of a portion of the value of your shares.

The following formula is used to determine how much cash can be extracted from a share holding via the cash extraction strategy:

Deciding which instalment to select for this strategy will generally depend on two factors:

Does the term to expiry of the instalment match your investment time horizon?

What level of gearing is suitable for your risk profile? (the higher the gearing the higher your tolerance for risk should be)

This should allow you to narrow down your search to just a couple of instalments, where the final factor may be the comparison of funding cost between issuers of each instalment.

Example

NAB is currently trading at $29.25. You presently own 2,000 NAB shares and wish to broaden your share exposure, that is re-weight your existing share portfolio. This will allow you to gain exposure to other sectors in the market and diversify your income stream. As an alternative to selling down your NAB holding you decide to compare this against converting the NAB shares for instalments, undertaking the cash extraction strategy. Out of many instalments available over NAB, you choose the one that best fits your risk profile, in this example a regular geared instalment.

Selling down NAB shares

Converting into NAB instalments*

Total number of shares

2,000

2,000

Price on implementation of the strategy

$29.25

$14.09

Level of gearing

n/a

60%

Number of shares sold / converted

1,000

2,000

Cash extracted

$29,250

$30,320*

Dividend income stream going forward^

$1,600

$3,200

Triggered a CGT event

Yes, on 1,000 shares

No, tax differed

The performance of the strategy is largely dependant on how the cash component is invested, coupled with the ongoing performance of the NAB shares. By diversifying into other sectors of the market, such as listed property trusts, you are able to create a more balanced portfolio, in the event that the banking sector underperforms. Your income stream, made up of dividends and franking credits, is also diversified.

Additionally you may receive tax benefits from pre-paid interest and the franking credits associated with dividends paid.

Main benefits of the strategy

Ability to leverage or diversity the existing portfolio without CGT consequences.

Maintain share exposure and income stream (dividends and franking credits).